The highest yielding and most-popular sterling bond funds

Bond funds are attracting money again – these are some of the best options to consider. 

The dramatic rise in UK interest rates, from 0.25% at the start of the year to 3.5% today, has caused investors to dump bonds, pushing up yields.

Just a year ago, investors were rewarded with a 1.2% annual returns from lending money to the UK government for a 10-year period – but now they get paid around 3.5% for owning the same debt.

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Bonds issued in pounds by large companies, known as sterling corporate bonds, also yield far more than a year ago, with the highest rated “investment grade” bonds carrying limited default risk.

This is fuelling demand for bonds from investors looking for income and investments with defensive properties in a world where the economy looks shaky and stocks are still far too expensive, according to some experts.

Calastone, the fund administrator, found that £1.7 billion flowed into fixed-income funds in the final quarter of 2022, compared with outflows of £6.3 billion from equity funds.

The group said: “New investor capital into these funds will receive more interest income than at any point in the last 14 years. The inflows also indicate that investors have begun to anticipate an end to the rate-hike cycle and so positioned themselves for a potential bond-market rally.”

But for investors looking to up their allocation to bonds, which funds yield the most and which have been attracting the most money? We answer by looking into the Investment Association’s Sterling Corporate Bond fund sector.

Which funds yield the most?

The distribution yields, which measures the most recent income payment to investors expressed as an annual figure, vary greatly in the corporate bond sector.

The highest yielding fund, as of January 2023, was the Liontrust Sustainable Future Monthly Income Bond fund. It distributes income monthly to investors, yielding 5.74%, and charges 0.57% in fees.

The yield is particularly high because the strategy distributes some capital appreciation as income, meaning that the value of the fund will grow less than rivals but the income it pays is higher. The true yield of the fund is 3.9%.

The next highest-yielding fund is the Schroder Sterling Corporate Bond fund, which yields 5.06%. The fund invests in riskier bonds than its rivals, which gives it a higher yield. 

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Other high-yielding sterling bond funds include: Schroder Long Dated Corporate Bond (4.64%); Close Sustainable Bond Portfolio (4.55%); Baillie Gifford Investment Grade Long Bond (4.5%) and interactive investor Super 60-rated Rathbone Ethical Bond Fund (4.5%).

Yield is not everything when picking a bond fund, however. Higher yields tend to come from riskier bonds, with longer maturity dates, measured by the “duration” of the fund. This makes them more vulnerable to economic stress and higher interest rates.

The outlook for bond prices will also impact the “total return” of a bond fund, which includes income paid and changes in bond prices in the calculation.

Generally speaking, investment firms are optimistic about fixed income investing in 2023. J.P. Morgan Asset Management says: “Bonds are offering income again and, we believe, will again be a good hedge, regaining their safe-haven status in times of market stress.”

It reckons that if stock markets fall this year, then bond prices will rise, as fixed income will once again become defensive now that central bank interest-rate hiking cycles are nearly complete.

Fidelity International takes a similar view. Global head of solutions and multi-asset Henk-Jan Rikkerink says: “Looking ahead, we do not expect bonds to perform so poorly or to be as positively correlated to equities in 2023 and we have recently moved overweight government bonds.”

Source: FE FundInfo, data as of 5 January 2023.

Which funds have attracted the most money?

Morningstar data shows that the most money flowed into a tracker fund in the last three months of 2022, with the Legal & General Short Dated Sterling Corporate Bond Index fund raking in £310 million. This strategy tracks the Markit iBoxx Sterling Corporates 1-5 Year index (a corporate bond index for debt in sterling) for just 0.08% in fees. It yields 2.7%.

The L&G Sterling Corporate Bond Index, which owns bonds with longer maturity dates, attracted £118 million over the same three-month period. It yields 2.2%.

The next most popular fund was the Artemis Corporate Bond fund (4.5% yield), attracting in £276 million, followed by Schroder All Maturities Corporate Bond (4.22% yield), bringing in £172 million, and then Royal London Investment Grade Short Dated Credit Fund (2.98% yield), attracting £160 million.

Source: Morningstar, 5 January 2022.

Which funds do we recommend?

Interactive investor recommends a number of bond funds on its Super 60 and ACE 40 lists. In the sterling corporate bond sector, they are Rathbone Ethical Bond (4.5% yield); CT UK Social Bond (2.63%); and Liontrust Sustainable Future Corporate Bond (4.24% yield).

Dzmitry Lipski likes the Rathbones Ethical Bond fund, which appears on both the Super 60 and ACE 40 lists.

Lipski said: “Bryn Jones has run this fund since 2004 and was joined by assistant manager Noelle Cazalis in 2016. They invest predominantly in investment-grade bonds. They use an approach that considers economic and political trends, company analysis and thematic ideas. Once investment themes have been developed, Jones and his team look for the best bonds to buy within that framework.

“When assessing which companies’ bonds to buy, the managers use the ‘four Cs plus’ process to help make their selections. These are: character (management’s ability to react to events); capacity (sources of liquidity and cash-flow analysis); collateral (assets that are pledged); and covenants. The ‘plus’ is conviction: Jones believes that to achieve long-term, above average performance, he must think differently from the market.”

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For CT UK Social Bond, he says the fund offers a unique approach to sustainable investing as a key part of the approach is through engagement, both in terms of evidence-gathering and influencing how the issuers can do more.

“While Simon Bond’s departure is a loss to the fund, his continued involvement via the social advisory committee is a positive and current manager Tammie Tang’s long tenure, involvement and commitment to the fund, should provide continuity that helps mitigate this loss.

“Tang will also benefit from the direct support of two experienced deputy managers and the well-resourced experienced team of investment analysts, as well as the additional support of the responsible investment team,” Lipski said.

For the Liontrust Sustainable Future Corporate Bond, Lipski says the fund is reasonably priced at 0.61% in fees and has outperformed the average return of funds in its peer group over the longer term.

“The fund is managed by four co-managers, including (since 2012) Stuart Steven, head of the sustainable future fixed income team,” he adds.